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Greenwood Gearhart
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February 2024: Market Commentary

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The stock market is having a decent start to the year with the S&P 500 up over 5% in just 6 weeks, continuing a rally from the fourth quarter built on improving economic growth and expectations of lower interest rates. Fears of recession, which dominated the narrative for much of last year, have fallen into the background as US GDP increased at a 3.3% annualized rate in the 4th quarter, handily beating economists’ projections. Likewise, inflation has fallen to just over 3% with the labor market still expanding at a healthy rate. Collectively, these data have created a “goldilocks” environment over the last couple months in which the Federal Reserve has signaled an end to its hiking cycle with markets leaning further into a “soft landing” or “no landing” narrative for the economy.

While undoubtedly a positive outcome, this enthusiasm is raising the stakes in the game of expectations for markets. The strong January jobs report illustrates this well, with the blowout report initially causing stocks to drop due to a surge in bond yields. The subsequent CPI release, which showed inflation unexpectedly tick higher, caused a similar move lower. While the market quickly bounced in both circumstances, it shows the degree to which markets are dependent right now on the path of interest rates. Markets paradoxically fear an economy that is too strong because it lowers the chances of the Fed cutting interest rates later this year, with Fed officials intentionally emphasizing this in recent statements.

Traders have also continued leaning into the winning trades from last year, such as the AI trade that defined many of the top movers. This momentum in some of last year’s winners is continuing the trend of return concentration, where a disproportionate share of return comes from just a handful of stocks. This creates a dynamic where certain stocks must really deliver blowout earnings reports to satisfy the market with anything less causing disappointment. Some stocks like META have delivered on this hype, while others such as TSLA fell on a less than rosy earnings report. Collectively, this dynamic in the biggest stocks has created some volatility, even as markets have steadily chugged higher on a relatively positive earnings season.

The strength in earnings overall is a reason to be cautiously optimistic that this rally could be part of a longer-term growth cycle. After all, it has continued even as bond yields have steadily risen in recent weeks amid hotter than expected inflation and jobs data. This means the market collectively sees earnings growth as continuing to rise to justify the higher prices. However, there are important signals to look for in coming weeks to signal this is the case.

Most notably, market breadth needs to improve, which means a greater percentage of stocks participating in the rally. So far, the equal-weight S&P 500 index has lagged to start the year, but it’s starting to improve versus the main index, which is encouraging. Small caps have also underperformed on the recent rise in yields but are starting to stabilize versus Large Caps. Given they are often a leading indicator of a growth cycle, their performance in the near-term will be important to watch. Then we have Nvidia reporting this week, which will be an important indicator of the staying power of the AI trade. Lastly, the market will be closely watching the next inflation reports to understand whether the recent increases are just blips in the downward trend, or in fact represent a floor, in which case the Fed will likely act further to bring it down.

In sum, markets have some supporting factors working in their favor right now, but the rapid rise in valuations increases the chances of some volatility in the near-term, particularly as it relates to any unexpected changes in monetary policy.  However, we will continue to monitor these developments closely and remain ready to act to add value in portfolios as opportunities arise.

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